(APOL) - Apollo Group - Paul Tracy, StreetAuthority Market Advisor newsletter

Paul Tracy, editor of the StreetAuthority Market Advisor newsletter, outlines the differences between real turnaround candidates versus the value traps that have little chance of recovery. Take a look at this featured expert’s commentary. Then read Tracy’s analysis of one of his corporate turnaround plays. FEATURE ARTICLE from October 31 Winners and Losers Not all corporate turnaround stories pan out. When once-great companies are unable to adapt to changing market conditions, they can eventually fail. A perfect example of this is Polaroid. The company's instant camera was tremendously popular in the 1970s, and Polaroid stock gained steadily throughout the decade. But the firm failed to adapt to new innovations -- digital cameras and other instant photography technologies eroded Polaroid's market. The company ultimately went bankrupt in 2001. Fortunately for investors, there are ways to separate the real turnaround candidates from the value traps that have little chance of recovery. While turnaround candidates certainly don't have to exhibit all of these traits to be successful, these are some of the key factors Paul Tracy and his team look for: Low Debt or Debt Reduction -- Companies with enormous debt loads generally have a much harder time turning around their operations. Significant debt burdens lead to high interest bills and less cash available to fund restructuring initiatives. In addition, companies with too much debt are more likely to go bankrupt, particularly when the economy slows down and overall business conditions deteriorate. When searching for turnaround candidates, Tracy and his team look for firms that already have relatively low debt loads. A good rule of thumb is to focus on stocks with debt-to-equity ratios (total debt divided by shareholder's equity) of less than 50%. Alternatively, if a firm does carry a higher debt load, then Tracy and his team prefer to focus on companies that have a viable plan for repaying their debt as part of their restructuring initiative. Carlos Ghosn, for example, made debt repayment the centerpiece of his turnaround plan; he started paying down debt almost immediately after joining Nissan. New Management Team -- Some companies, such as Apple Computer, have managed successful turnarounds without a management shake-up. But in many cases, a new management team is key to the recovery of fallen angels. Oftentimes older firms fall into a rut -- even quality, longstanding managers can fail to see new opportunities or adapt to changing conditions. For example, Nissan's management team clung to the traditional practice of lifetime employment even after it became clear that labor costs were too high for the company to survive. While the system promoted extreme employee loyalty and high quality in the 1980s, it wasn't compatible with the weak Japanese economy of the mid-1990s. A new management team with a fresh focus can often reinvigorate companies that have lost their way. In Nissan's case it took a total outsider -- a foreigner with limited business experience in Japan -- to see what changes needed to be made. Long Operating History -- The best turnaround candidates are often older firms with a long operating history. Such firms have proven that they have a successful, workable business model; most have simply lost their way in the short run due to mismanagement or a failure to adapt to new business conditions. By contrast, relatively new companies that are financially distressed or underperforming may simply not be solid, viable businesses. Such firms have not yet established their business models and brand names. Thus, it's much harder to know if less-established firms will successfully turn things around. Divestments -- Like Tyco, some of the best turnaround candidates are firms that divest or sell off underperforming business units. Sometimes ambitious management teams will enter ventures outside a company's core business. Expansion and business diversification aren't necessarily bad moves. But excessive expansion into unrelated business lines can divert management's focus away from its core business. And if a company's main business lines and products are ignored too long, then performance can clearly suffer. In addition, even the largest companies have only a limited supply of funding to invest in various business lines -- over-expansion can starve key product and business lines of precious capital. One of the easiest ways to turn around an underperforming firm is to sell off or simply eliminate these non-core businesses and unprofitable products. This allows a firm to re-focus attention and available capital on its most profitable markets. Cost-Cutting -- The best turnaround plans usually involve some degree of cost-cutting. In fact, cutting out unnecessary or unproductive costs is one of the fastest ways for companies to boost profitability. A key component in cost cutting usually involves a firm's labor force. Older firms often develop bloated labor costs and unnecessary overhead. By reducing employee counts or benefits, management can quickly trim these excessive costs. Meanwhile, some companies can cut costs and boost efficiency by redesigning manufacturing processes or simply refinancing debts. New Products, New Markets -- As companies mature and expand, they often come to saturate their core markets. Earnings and revenue growth tend to slow when this happens. But just because a company's traditional markets are maturing doesn't mean it can't grow. For example, under Ghosn, Nissan was able to expand aggressively overseas by designing car models to appeal specifically to American and European consumers. And in Motorola's case, the company reinvented itself as a designer of popular mobile telephone handsets rather than building its semiconductor chip business. Rapid expansion into this new market helped Motorola reignite its growth. With these points in mind, Tracy and his team recently spent countless hours combing the investment landscape in search of compelling corporate turnaround plays. In the text that follows, they profile one stock that fits the bill. Apollo Group (APOL) Business Overview Apollo Group runs the largest private university in the U.S. The company is best known for its University of Phoenix (UOP) unit, which offers both online and campus-based education to more than 320,000 students. In addition to the main UOP brand, Apollo targets younger students with its Axia division; students in this division can acquire an associate degree in a wide variety of course disciplines. Turnaround Plan Apollo was truly an impressive performer from 2000 through early 2004, returning roughly +1,000% over this period. But over the past two-and-a-half years, Apollo has stumbled. Specifically, the company has suffered from declining growth in new student enrollments, as well as a falling retention rate. Thanks to a string of negative surprises, shares of APOL have tumbled more than -65% from their early 2004 highs. But there's reason to believe APOL can turn around its business. The company has absolutely no debt, and while growth has slowed, APOL still generates more than $500 million per year in free cash flow. In addition, the company sports a near 30% operating margin. While growth may have stumbled, Apollo is still a highly profitable business. Moreover, APOL is taking some important steps to address its falling enrollment growth and faltering retention rate. First, the company has greatly stepped up its marketing and promotional efforts. At the beginning of January, APOL employed 3,500 "enrollment counselors" -- employees who help promote APOL's courses to students who have expressed interest. By the end of September, APOL had boosted its base of enrollment counselors to more than 4,300. In addition, APOL has stepped up its marketing on both Ad.com and Monster.com. These two sites are frequented by working adults -- the very demographic that Apollo and University of Phoenix target. On the retention front, Tracy and his team like APOL's long-term strategy with its Axia subsidiary. While the UOP division targets older adults, Axia is aimed at young adults that are 18-23 years old. Axia offers associate degrees at a much lower cost than a degree at University of Phoenix. APOL has found that nearly half of Axia students go on to enroll in UOP after completing their studies. This conversion rate is rising rapidly, thereby increasing the pool of probable students for University of Phoenix. Even better, more than 90% of Axia students who enroll in UOP go on to finish their degrees at UOP. This retention rate is far higher than the company average. Meanwhile, a recent management shake-up may also help breathe some vigor into Apollo's turnaround plan. APOL's President, Brian Mueller, was appointed to his role at the beginning of January. Mueller is heading up the company's turnaround plan, and Tracy’s team sees the management shuffle as another positive for APOL. This article highlights the commentary of Paul Tracy for the Zacks.com audience. Paul Tracy provides insightful analysis, market commentary, and favorite recommendations on a timely basis in "StreetAuthority Market Advisor" newsletter. 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